Dividend delights: 3 shares set to deliver sustainable income

12th February 2016

Investors relying on equities for income have been hit by stockmarket turbulences but there are still companies you can rely on.

The search for income had been increasingly difficult for investors over the past couple of years and they have found a home in the stockmarket but the sell-off in global markets, particularly in commodities, has left people concerned about dividend sustainability in UK corporates.

This concern is backed up by Rio Tinto and Rolls Royce cutting dividends and the latest Capita Dividend report forecasts dividend payouts will fall this year for the first time since 2010.

Michael Clark, portfolio manager of the Fidelity MoneyBuilder Dividend an Enhanced Income fund, said investors needed to priortise dividend sustainability.

‘We will definitely see areas of the market where dividends are under pressure throughout 2016. Prioritising dividend sustainability will be crucial for income investors,’ he said.

‘I am happy to be completely out of some sectors, such as mining, even though share prices have collapsed. I remain cautious on the oil and gas majors as dividends that looked challenged at $70-80 oil are seriously under threat at an oil price of $30. There are also still question marks on the ability of banks in state ownership to grow dividend payments as they face the prospect of paying out further compensation for miss-sold payment protection insurance (PPI).’

He said pharmaceuticals, fixed-line telecoms, consumer goods and regulated utilities, are areas he would highlight ‘for safe and growing income’.

‘There is particularly good visibility of returns in the regulated utilities such as the water and electricity companies, given that parameters are set for the companies in a five year regulatory cycle,’ he said.

Clark also highlighted three stocks he believes will deliver sustainable income and that are diversified away from the areas of yield stress in the market.

Legal & General

Clark has recently initiated as position in the insurer, which he expects to sustain dividend growth over the next three years.

‘L&G operates in – and in some cases dominates – markets that provide strong long term structural growth. The group has adapted to negative developments in the individual annuity market by increasing capital allocation to the bulk annuity market where returns are attractive and barriers to entry are high,’ he said.

‘International expansion should increasingly present opportunities as L&G seeks to replicate its de-risking proposition in the US and other markets. This is a cash generative business, with a strong dividend yield (5.5%). I expect the group to sustain c.10% growth in dividends for the next three years.’

Capita

Clark said the support services company is ‘consistent in its delivery of profits versus expectations and a company that rarely disappoints, fitting well with my philosophy of investing in safety of income at a reasonable price’.

He added: ‘It is a dominant player in its markets with high barriers to entry, high visibility and a strong management team that can identify new opportunities, with exposure to the UK and Germany.

‘The company has a solid mid-single digit organic growth profile with further potential for 5% growth from acquisitions, offering a compound annual growth rate of c.10% in earnings. Capita also has strong cash conversion and the dividend yield of 3% is well-supported.’

Severn Trent

Regulated water utility Severn Trent has ‘good visibility of returns’ as water regulator Ofwat sets the parameters for regulation on a five-year cycle.

‘I look for safety in the form of predictability – companies where I can make a credible projection of the returns a company will make. In a stable regulatory environment the regulated utilities are ideal investments for an income strategy as they also pay a reliable dividend. Severn Trent currently yields over 3.5%,’ he said Clark.

‘Consolidation is also likely to occur in this sector, and has already begun with Pennon’s takeover of Bournemouth Water in 2015. The larger players such as Severn Trent stand to benefit if they can drive out efficiencies from such deals.’